Mark Lister, 15 May 2017

The Reserve Bank baffled a whole lot of people with its statement last week, and is getting a bit of grief for giving confusing guidance. Reading between the lines, I think there’s a method to the madness.

So let’s recap. For a start, they left the Official Cash Rate (OCR) unchanged. That bit was completely expected.

However, what wasn’t expected was virtually no change to the longer-term OCR forecasts or the outlook for inflation. That’s why we saw a sharp fall in the NZ dollar and interest rates immediately following the decision.

It’s not surprising markets are confused. The February statement from the Reserve Bank had the OCR flat until late 2019, the annual inflation rate staying below two per cent for another two years and the currency (on a trade-weighted basis) staying around current levels for the foreseeable future.

Since that was all finalised, a lot has changed, both here and overseas. Global economic activity has improved, the risk around the French election is behind us, and financial markets are in generally good spirits.

On the local front, dairy prices have stabilised, making the $6.00 Fonterra payout look safe. Labour market and migration figures have both proved stronger than expected, while the currency has fallen five per cent.

Most importantly, the annual inflation rate for the March quarter hit 2.2 per cent, well above Reserve Bank forecasts for a 1.5 per cent rise. In addition, two-year forward inflation expectations rose to 2.17 per cent, the highest since 2014.

That latter point shouldn’t be underestimated. When the OCR was cut last year, a key reason was these inflation expectations falling too far. It’s not unreasonable to assume the Reserve Bank would take an equal amount of notice when these go back in the other direction.

Most assume the Reserve Bank has chosen to write off the recent inflation uplift as temporary, not fully believing the spike will last, or that it will make its way into people’s pockets via wage rises.

That might be the case, especially as the volatile oil price was a factor. Still, there was some underlying strength in the last inflation report, and you can’t deny the rise in inflation expectations.

The people that work at the Reserve Bank are smart, and I don’t believe any of this is lost on them. They know full well the OCR is going up long before September 2019, and that inflation is back in the game.

But they’ll also be quietly content about how things are playing out this year.

The currency has started coming off the boil, the dairy sector is getting its mojo back, and Auckland house prices just registered their slowest rate of growth in five years. Overseas interest rates have ticked up, helping push floating mortgage rates to an 18-month high.

Why would they jeopardise any of that by unnecessarily fiddling with their forecasts? Let the economists and traders flounder a little, the stuff that matters is all falling into place.

This article was published by The New Zealand Herald on 15 May 2017 under the title ‘Mark Lister: Method to RBNZ’s madness’.